(Any opinions expressed here are those of the author and not necessarily those of Thomson Reuters)

The effective rate of corporate taxation in India is 23.2 percent for companies with an income of 100 million rupees ($1.6 million) or more, which is lower than the statutory rate by a full 10 percentage points. This is due to incentives to promote investments or to direct investments towards targeted activities.

But smaller companies have not been able to fully avail of the incentives. A study of 56,4787 companies by the Department of Economic Affairs for the year 2013-14 estimated that companies having an income of less than 100 million rupees ($1.5 million), excluding loss making companies, pay an effective corporate tax rate of 26.3 percent. These companies constitute more than 50 percent of firms in the study but earn less than 10 percent of the total income before tax.

Large companies with income of over 5 billion rupees ($79.7 million), numbering only 263, account for 60.3 percent of pretax income for all the companies and pay an effective tax of 20.68 percent against the statutory rate of 33.99 percent.

Other medium-sized companies numbering 6,325 had a 29 percent share in income before tax and a 31 percent share in taxes. The effective tax rate was 24 percent.

Also, the benefit of incentives accrues more to the public sector than their private counterparts. The 221 PSUs in the study earned 24 percent of the total pre-tax income, but paid only 20 percent of total taxes. As a result, the effective rate of taxation for PSUs was 19 percent against 24 percent for private players.

The projected revenue loss due to incentives in 2014-15 is estimated was 624 billion rupees ($9.94 billion). Accelerated depreciation and exemption on export profits from SEZs and power companies account for two-thirds of total incentives.

Accelerated depreciation alone account for one-third of revenue loss. But that is not really the right way to estimate revenue loss since total depreciation has to be paid in any case. With acceleration, the tax payable is only postponed and consequently, only the interest borne by government on the incentive should be considered as genuine loss.

When it comes to power, the sector was slow to attract investment because of excessive regulation, so removing incentives should not be considered. What about SEZs? Exports are critical and in an intensely competitive market, every country compensates exporters one way or the other. And benefits for companies in SEZs are anyway minimized by MAT against original tax exemption of export profits.

It would not be prudent to withdraw the incentives unless corporate tax is brought down substantially. A combination of tax incentives and a reasonable tax rate is best for a transitional economy like India.

(Any opinions expressed here are those of the author and not necessarily those of Thomson Reuters)

The effective rate of corporate taxation in India is 23.2 percent for companies with an income of 100 million rupees ($1.6 million) or more, which is lower than the statutory rate by a full 10 percentage points. This is due to incentives to promote investments or to direct investments towards targeted activities.

But smaller companies have not been able to fully avail of the incentives. A study of 56,4787 companies by the Department of Economic Affairs for the year 2013-14 estimated that companies having an income of less than 100 million rupees ($1.5 million), excluding loss making companies, pay an effective corporate tax rate of 26.3 percent. These companies constitute more than 50 percent of firms in the study but earn less than 10 percent of the total income before tax.

Large companies with income of over 5 billion rupees ($79.7 million), numbering only 263, account for 60.3 percent of pretax income for all the companies and pay an effective tax of 20.68 percent against the statutory rate of 33.99 percent.

Other medium-sized companies numbering 6,325 had a 29 percent share in income before tax and a 31 percent share in taxes. The effective tax rate was 24 percent.

Also, the benefit of incentives accrues more to the public sector than their private counterparts. The 221 PSUs in the study earned 24 percent of the total pre-tax income, but paid only 20 percent of total taxes. As a result, the effective rate of taxation for PSUs was 19 percent against 24 percent for private players.

The projected revenue loss due to incentives in 2014-15 is estimated was 624 billion rupees ($9.94 billion). Accelerated depreciation and exemption on export profits from SEZs and power companies account for two-thirds of total incentives.

Accelerated depreciation alone account for one-third of revenue loss. But that is not really the right way to estimate revenue loss since total depreciation has to be paid in any case. With acceleration, the tax payable is only postponed and consequently, only the interest borne by government on the incentive should be considered as genuine loss.

When it comes to power, the sector was slow to attract investment because of excessive regulation, so removing incentives should not be considered. What about SEZs? Exports are critical and in an intensely competitive market, every country compensates exporters one way or the other. And benefits for companies in SEZs are anyway minimized by MAT against original tax exemption of export profits.

It would not be prudent to withdraw the incentives unless corporate tax is brought down substantially. A combination of tax incentives and a reasonable tax rate is best for a transitional economy like India.

(Any opinions expressed here are those of the author and not necessarily those of Thomson Reuters)

There were no major policy changes in last year’s budget, perhaps because the new government lacked the time to prepare. But Finance Minister Arun Jaitley has indicated that the upcoming budget on Feb.28 will bring India’s tax system in line with international practices to facilitate and encourage investments.

There are several factors that will make budgeting a little easier this year – inflation is down, crude prices have nearly halved, and a bullish stock market will absorb disinvestment by the government.

But there are also limitations. The 14th Finance Commission has recommended an increase in states’ share of tax revenues. Also, except for the United States, major world economies are struggling, which is bad for the country’s export sector.

It is within these parameters that Jaitley will have to frame his budget. Surely, the government will have to take a long-term view to ensure that industrial growth is gradually pushed up in order to generate employment and increase revenue for the government in future budgets. This will call for a broad spectrum of changes in the tax system.

A couple of reasons why industrial growth slowed down and foreign investment declined were the introduction of GAAR and retrospective taxation. The tax system should be cleaned of such provisions and made transparent and clear-cut.

Presently, corporate tax is high in comparison with other Asian countries where the tax rate is around 25 percent – a level that can be reached at best in two successive budgets. In the next budget, either surcharges or cess will have to be removed as a first step, or the rate of corporate taxation correspondingly reduced. This will stimulate growth and generate employment.

Exports need the government’s support considering weak international markets and excessive competition. Hence it is imperative that the profitability of export earnings be restored by reducing tax on export profits. More specifically, MAT in respect of export profits will have to be reduced.

Another reason why investment has been sluggish is that domestic demand is not strong enough. In 2014-15, consumption of durable consumer goods declined 9 percent and the total manufactured consumer goods increased a mere 0.7 percent. To energize demand and at the same time provide relief to taxpayers from inflation, the exemption threshold for income taxation has to be raised and tax relief for home loans increased.

The budget has to introduce third-generation reforms to galvanize the economy. Governance (rules and regulations) should be made almost automatic without requiring approval from the government.

Expenditures need to be reduced in order to trim the fiscal deficit as planned, and that is possible if subsidies, which currently constitute about a fifth of revenue budget, are aggressively cut and leakages plugged. These measures will put the budget on a sustainable path and become a starting point for high growth.

(Any opinions expressed here are those of the author and not necessarily those of Thomson Reuters)

There were no major policy changes in last year’s budget, perhaps because the new government lacked the time to prepare. But Finance Minister Arun Jaitley has indicated that the upcoming budget on Feb.28 will bring India’s tax system in line with international practices to facilitate and encourage investments.

There are several factors that will make budgeting a little easier this year – inflation is down, crude prices have nearly halved, and a bullish stock market will absorb disinvestment by the government.

But there are also limitations. The 14th Finance Commission has recommended an increase in states’ share of tax revenues. Also, except for the United States, major world economies are struggling, which is bad for the country’s export sector.

It is within these parameters that Jaitley will have to frame his budget. Surely, the government will have to take a long-term view to ensure that industrial growth is gradually pushed up in order to generate employment and increase revenue for the government in future budgets. This will call for a broad spectrum of changes in the tax system.

A couple of reasons why industrial growth slowed down and foreign investment declined were the introduction of GAAR and retrospective taxation. The tax system should be cleaned of such provisions and made transparent and clear-cut.

Presently, corporate tax is high in comparison with other Asian countries where the tax rate is around 25 percent – a level that can be reached at best in two successive budgets. In the next budget, either surcharges or cess will have to be removed as a first step, or the rate of corporate taxation correspondingly reduced. This will stimulate growth and generate employment.

Exports need the government’s support considering weak international markets and excessive competition. Hence it is imperative that the profitability of export earnings be restored by reducing tax on export profits. More specifically, MAT in respect of export profits will have to be reduced.

Another reason why investment has been sluggish is that domestic demand is not strong enough. In 2014-15, consumption of durable consumer goods declined 9 percent and the total manufactured consumer goods increased a mere 0.7 percent. To energize demand and at the same time provide relief to taxpayers from inflation, the exemption threshold for income taxation has to be raised and tax relief for home loans increased.

The budget has to introduce third-generation reforms to galvanize the economy. Governance (rules and regulations) should be made almost automatic without requiring approval from the government.

Expenditures need to be reduced in order to trim the fiscal deficit as planned, and that is possible if subsidies, which currently constitute about a fifth of revenue budget, are aggressively cut and leakages plugged. These measures will put the budget on a sustainable path and become a starting point for high growth.

(Any opinions expressed here are those of the author and not necessarily those of Thomson Reuters)

The Reserve Bank of India’s decision to reduce interest rates by 25 basis points on January 15 was a pleasant surprise, not because of the cut but due to the timing, as the bi-monthly policy review was still a couple of weeks away.

The central bank’s assessment was that decline in vegetable and fruit prices was sharper than expected and price pressure on cereals had eased. International commodity prices, particularly crude oil, had also dropped. The government’s reiteration of its commitment to a strict fiscal roadmap also helped. In the end, the RBI must have been convinced that price trends were not temporary but durable.

But how big will the impact of the repo rate cut be? Markets were undoubtedly elated by the unexpected announcement, and there were indications that the change in the RBI’s policy stance may be enduring, with more cut rates likely during the year.

But industry players seem unimpressed. First, the cut has to be reflected in the rate that commercial banks charge their borrowers. That, however, is not automatic and it is quite possible that the rate of interest on bank credit may not be reduced to the full extent the repo has been.

Second, even if commercial banks fully respond to the repo reduction, the impact on EMIs for home and car loans will not be significant. For instance, against a loan of 25,00,000 rupees payable in 20 years, the reduction in EMI will be 482 rupees from the monthly payment of 24,959 rupees. That is not going to rev up demand for homes.

The impact will be even less for the manufacturing industry. According to the Annual Survey of Industries, interest payments by industries were 26 percent of profits before tax. The 0.25 percent cut in rate will increase pre-tax profits by a mere 0.27 percent. Similarly, reduction in cost of production and prices will be a mere 0.06 percent.

Clearly, the 25 bps reduction is not a motivating force and will not revive industrial growth. What is relevant, however, is the change in the RBI’s thinking. If inflation weakens further, more rate cuts will follow. Had the January rate cut been significant, the impact would have been enough to revive India’s stagnant industries. Therefore, the RBI should cut the repo rate by at least 50 bps at its next policy review on February 3.

(Any opinions expressed here are those of the author and not necessarily those of Thomson Reuters)

The Reserve Bank of India’s decision to reduce interest rates by 25 basis points on January 15 was a pleasant surprise, not because of the cut but due to the timing, as the bi-monthly policy review was still a couple of weeks away.

The central bank’s assessment was that decline in vegetable and fruit prices was sharper than expected and price pressure on cereals had eased. International commodity prices, particularly crude oil, had also dropped. The government’s reiteration of its commitment to a strict fiscal roadmap also helped. In the end, the RBI must have been convinced that price trends were not temporary but durable.

But how big will the impact of the repo rate cut be? Markets were undoubtedly elated by the unexpected announcement, and there were indications that the change in the RBI’s policy stance may be enduring, with more cut rates likely during the year.

But industry players seem unimpressed. First, the cut has to be reflected in the rate that commercial banks charge their borrowers. That, however, is not automatic and it is quite possible that the rate of interest on bank credit may not be reduced to the full extent the repo has been.

Second, even if commercial banks fully respond to the repo reduction, the impact on EMIs for home and car loans will not be significant. For instance, against a loan of 25,00,000 rupees payable in 20 years, the reduction in EMI will be 482 rupees from the monthly payment of 24,959 rupees. That is not going to rev up demand for homes.

The impact will be even less for the manufacturing industry. According to the Annual Survey of Industries, interest payments by industries were 26 percent of profits before tax. The 0.25 percent cut in rate will increase pre-tax profits by a mere 0.27 percent. Similarly, reduction in cost of production and prices will be a mere 0.06 percent.

Clearly, the 25 bps reduction is not a motivating force and will not revive industrial growth. What is relevant, however, is the change in the RBI’s thinking. If inflation weakens further, more rate cuts will follow. Had the January rate cut been significant, the impact would have been enough to revive India’s stagnant industries. Therefore, the RBI should cut the repo rate by at least 50 bps at its next policy review on February 3.

(Any opinions expressed here are those of the author and not necessarily those of Thomson Reuters).

The stock market woke up from its long hibernation in 2014, with the Sensex rallying 30 percent during the year. If not for the market correction in the last two months, Indian bourses would have been the best performers in the world.

The recovery was solely due to the optimism generated by Prime Minister Narendra Modi, with FII investment in Indian equity crossing $16 billion.

But Modi confronted opposition in the Rajya Sabha, where the BJP-led coalition is in minority. Lack of support from opposition parties stopped bills from being passed. However, the government introduced ordinances (decrees) in respect of coal and insurance – the first to get industry going and the second to create an environment for reform and attract foreign investment. The government also made amendments to the Land Acquisition Act through an ordinance, which is yet to receive the president’s approval.

The market now believes that the prime minister means business. Finance Minister Arun Jaitley has also indicated that the next budget to be presented in February will adopt a tax system which is globally compatible, adds clarity to the tax liability and is in tune with internationally comparable tax levels. The budget has raised expectations and will be an important trigger for the market.

But there can be disruptions. The rate of interest, which is a prime consideration with the market, is outside the ambit of the government. It is the exclusive domain of the RBI and, with inflation targeting initiated by governor Raghuram Rajan, can take some time to be moderated.

There will also be external factors to contend with. First, world economic growth (except the U.S.) is likely to drop, making exports a little difficult. Second, there is no certainty about the international prices of crude oil. If prices rise again, energy importing countries like India will be hit both in terms of inflation and current account deficit. Third, the U.S. Federal Reserve is expected to increase interest rate which may reduce FII inflows into emerging market economies and check rising equity prices. Fourth, there is always a possibility that monsoon will disappoint.

Even so, if the budget measures up to the indications given by the finance minister, it will be a strong driver of the market. To sustain the bull market, the government will have to keep the wheels of the reform process running, which is likely under Modi.

Most policy parameters appear to be very positive and corporate growth and profitability should improve. With higher earnings per share and faster corporate growth, PEG (price/earnings to growth ratio) will be lower, creating enough space for share prices to rise further. The Sensex could possibly rise 20-25 percent in 2015.

(Any opinions expressed here are those of the author and not necessarily those of Thomson Reuters)

In the last three years, budget deficit has been reined in from 5.7 percent to the targeted 4.1 percent. Much of the decline came from a cut in capital expenditure because tax revenues were less than budgeted and current expenditures proved too sticky. Finance Minister Arun Jaitley is again faced with the same problem and a cut in capital expenditure is most likely if the government is to achieve its 2014/15 fiscal target.

It is not often appreciated that most of the government’s tax revenue comes from industry, whether it is from corporation tax, income tax, excise or import duties. A minimum of 8 percent growth in industry is necessary for the finance minister to have the freedom to implement projects without any fear of increasing the budget deficit.

But industry has been stagnant for the past three years and unable to generate the expected revenue. In the current year, the shortfall in tax revenue is likely to be 1.05 trillion rupees despite the fall in international oil prices and resources to be mobilized from disinvestment.

Jaitley has to make a choice between achieving the deficit target or maintain capex and let the deficit jump slightly. A similar choice confronted his predecessor P. Chidambaram, who opted for a lower deficit by cutting outlay.

Should Jaitley do the same? Certainly not, even though rating agencies may temporarily downgrade India’s credit rating. The reason is that the government’s first priority should be to get industry back on its feet to enable it to generate tax revenues, because this alone can reduce the budget deficit. And the first step in this direction is to implement stalled capital projects which can create demand for industry and kickstart recovery.

A budget deficit emerging from capital expenditure is much less harmful than when it emerges from current expenditure, because the latter means the government has to borrow capital to fund consumption. This reduces the total savings in the economy and puts pressure on prices. Borrowing for capex does mean that the government’s over-presence in the debt market will push up interest rates, but there is no reduction in savings and no pressure on prices. The government should try and bring the revenue deficit to zero, but not by cutting capital expenditure.

The revival of industry due to higher capital expenditure will open up sources of tax revenue for the government in subsequent years. For instance, if the budget deficit in the current year is 4.5 percent but ensures industrial recovery in 2015-16, there will be buoyancy in revenue which will reduce deficit in future. But the need to cut current expenditure to reduce fiscal deficit to zero still remains.

(Any opinions expressed here are those of the author and not necessarily those of Thomson Reuters)

If Finance Minister Arun Jaitley’s comments from last week are any indication, the union budget in February has the potential to usher in a new fiscal architecture in India.

“There was a misconception that higher tax rates lead to higher tax revenues … direct and indirect tax rates have to be brought to reasonable levels so that the basket increases and there is no incentive for evasion,” Jaitley said. That is how India’s first wave of reforms started in 1991 under the Narasimha Rao government (which lost pace and direction subsequently).

Surely, revenue – earned from taxation of incomes, commodities and services – is the prime consideration for a finance minister in order to keep the budget deficit in check.

The main source of government revenue comes from taxation of incomes, particularly from profits of the corporate sector. Presently, this sector generates more than a third of the central government’s gross tax revenue even though it is not in the prime of health. Production in the manufacturing sector is nearly static and profits come mainly from inflation. Had industry been growing faster, the government would have already reached its target of zero revenue deficit.

This has not happened because the previous Congress-led government increased the tax liability of the corporate sector by adding education cess and surcharges. The effective tax rate consequently climbed from 30 percent to 34 percent.

Many other countries have lowered their tax rates. Brazil has cut its rate to 25 percent, China to 25 percent, Germany to 29.5 percent, Canada to 26.5 percent, UK to 21 percent, Singapore to 17 percent, and so on.

The commonly accepted model corporate tax rate is 25 percent. This is possibly for India, although the process has to be gradual, starting with the next budget. As a first step, corporate tax should be freed of surcharges and cess so that the tax rate comes back to 30 percent.

Tax reduction will have a two-way effect. First, it will increase profitability of companies, attract more investment and generate growth. That means more revenue for the government from corporate profits, excise and customs. Second, lower taxation will discourage tax evasion.

Jaitley’s first full-year budget has to lay out a sound plan for policy reforms which can transform the economy.

(Any opinions expressed here are those of the author and not necessarily those of Thomson Reuters)

The contraction of exports by 5 percent in October will pull down industrial growth and bloat current account deficit. The fall in exports may not be due to a chance fluctuation but a warning of things to come. There are strong reasons to suggest India’s export woes are due to worldwide trends which need to be understood so that the country can benefit from them.

In the past seven months, exports have not increased consistently, even though there have been subdued bursts during some periods. For instance, exports in February and September exceeded $28 billion, only to fall back again. The increase in the April-October period (0.5 percent) was also not significant enough to indicate an improvement.

There are two reasons why exports have been static in India and many other countries. The first is stagnancy in major world economies. The United States is possibly the only developed country that is still on its feet. In the third quarter of the current year, the U.S. GDP was up 3.5 percent, but the EU is waiting for a push to get up again. Greece, Spain, Portugal and Italy are on the verge of a debt crisis, and France is surprisingly on the verge of a recession with GDP growth at 0.3 percent. Germany’s growth of 0.1 percent suggests it is also staring at negative growth.

The ECB is fiddling with negative interest rates and has gone in for quantitative easing, an experiment the U.S. tried with some success. The Bank of Japan also tried the same approach, but the country went into recession before any real effect could be felt, forcing Prime Minister Shinzo Abe to call for fresh polls.

The second reason for the fall in India’s exports is the realignment of major currencies compelled by these economic conditions. With the U.S. being the only country with high growth, the dollar has gathered a lot of muscle. Almost every currency has depreciated against the dollar. Among the BRIC countries, Brazilian real and South African rand fell 5 percent in the last 10 months. The Russian ruble is the worst performer with a fall of 30 percent. Even the euro has been cut down to size, dropping 10 percent against the dollar.

The relative weakening of currencies against the dollar decides the trade advantage of different countries. Those with devalued currency gain advantage by being in a position to grab a part of the international trade share from others. Since the rupee did not weaken enough, India’s exports became less competitive, and consequently lost its share of world trade to others.

It will take quite some time for Europe and Japan to get out of their economic troubles. Consequently, the change in the currency matrix will not be reversed anytime soon. The only way for India to regain its foothold is by making exports more competitive by allowing the rupee to fall to 64-65 against the dollar.